The economic impact of a higher dollar and interest-rate rises

We are in the middle of a central bank 24 hours and of course last night the US Federal Reserve continued its recent habit of only raising interest-rates just before Christmas.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent. The stance of monetary policy remains accommodative,

On the face of it not much of a change and it is only to as they put it 3/4 percent. However in the modern era there is a significance in that it is in a world of ZIRP ( Zero Interest Rate Policy) and indeed NIRP where N = Negative. This has been highlighted this morning by one of the forerunners of the NIRP world which is the Swiss National Bank.

The Swiss National Bank (SNB) is maintaining its expansionary monetary policy. Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is unchanged at between –1.25% and –0.25%.

So we have another perspective which is that the spread between these two central banks is now 1.5% which is small in absolute terms but in these days is a lot. Also I note that an interest-rate of -0.75% is “expansionary” whereas one of 0.75% is merely “accommodative”. Oh and the SNB isn’t entirely convinced so we get yet more rhetoric from it.

At the same time, the SNB will remain active in the foreign exchange market as necessary, while taking the overall currency situation into consideration.

Already this morning a country which was previously expected to lower interest-rates has kept them unchanged as Norway remains at 0.5%. Although here there is also clearly an effect from the higher price of crude oil. Meanwhile later we will hear from the Bank of England which cut Bank Rate in August a move which I argued was unwise at the time and looks even worse now. No wonder Governor Mark Carney has moved onto discussing climate change rather than monetary policy or sledgehammers!


It was only on Monday I was looking at the return of the bond vigilantes and overnight they have been active in some areas. For example the US ten-year Treasury Note yield has risen to 2.6%. It was only in early November that it was 1.78%. There have been effects in that period from the likely fiscal plans of President-Elect Trump and expectations for yesterday evening’s interest-rate rise but there was a further kicker. From the Guardian

But investors were caught out by surprisingly bullish comments from Fed chair Janet Yellen in the wake of the announcement and by projections showing that 11 of her 17 policy-making colleagues see borrowing costs rising another three times in 2017.

So not only was there an actual increase but the future path moved higher although to be more precise steeper as the Federal Reserve is really only projecting faster moves to a particular level. There is the obvious cautionary note that we were promised “3-5” interest-rate rises for 2016 by John Williams of the San Francisco Fed and got only one. But this time around the return of some inflationary pressure seems set to be on their minds.

This has seen the German 10 year yield rise back up to 0.36% in spite of the ongoing QE from the ECB. Whilst we are looking at this the “safe haven” problem they claimed to have fixed if getting worse as the two-year German yield is now -0.78%. Meanwhile the Bank of England has spent some £3 billion this week alone on a QE program described as a “sledgehammer” only for the UK Gilt ten-year yield to go back to 1.5% which is higher than when it came out of the tool cupboard. My Forward Guidance is for a sharp increase in inflation in the use of the word counterfactual.

Across the world in Japan there was plenty of work to do as the trend was against the recent promise of the Bank of Japan to keep its benchmark yield at 0%. I will explain later why they may have needed to sober up Governor Kuroda to authorise this but it must have been a busy day over there to keep it as low as 0.08%.

Dollar Hollar

If we look at the fact that the Japanese Yen has dropped sharply to 118 versus the US Dollar you will understand why the keys to the Sake cabinet at the Bank of Japan may have to have been taken off its Governor. All his Christmas wishes have come true in spite of the fact he is unlikely to celebrate it. From 115 to 118 in a manner described by Alicia Keys as “Fallin'” or by Status Quo as “Down Down” . It seems to have affected Prime Minister Abe so much he is going to join Vladimir Putin in a hot spring later.

Mario Draghi will be pleased also as the Euro slips below 1.05 versus the US Dollar as it and the UK Pound £ (1.253) get pushed lower but remain in station.

For the US itself then we see a further tightening of monetary policy via the US Dollar which has risen overall by about 1.5% since the interest-rate rise announcement. As it was expected it must be forecasts via the “dot plots” for 2017 that have changed things. Via this route monetary policy has an effect before it happens or in fact can have an impact even if it never happens something which has led to central bankers to get drunk on the implications. Care is needed though because for any real economic impact the changes and moves need to be sustained for a period.

Bank of England

This is left rather in disarray by this. If it was a schoolboy(girl) it would be in the corner wearing a dunces cap. This is the problem of having a Governor who is a “dedicated follower of fashion” when fashions change! Should the US Federal Reserve deliver on its interest-rate promises then Mark Carney will look very out of step as inflation rises above its target. Also his “sledgehammer” of QE is currently being swept aside in the UK Gilt market by worldwide trends. No wonder he is now opining on climate change and income inequality although those unfamiliar with him would do well to note his appalling record in any form of Forward Guidance. He has not be nicknamed the “unreliable boyfriend” only in jest.


As ever let us look at the impact on the real economy of this. In itself a 0.25% interest-rate rise should not have much impact but the effect via the US Dollar will be powerful. Let us start with the US economy as we have a benchmark from Fed Vice-Chair Fischer which I looked at on November 9th last year.

The New York Fed trade model suggests that a 10 percent appreciation of the U.S. dollar is associated with a 2.6 percent drop in real export values over the year. Consequently, the net export contribution to GDP growth over the year is 0.5 percentage point lower than it would have been without the appreciation and a cumulative 0.7 percentage point lower after two years

The Dollar Index has in fact risen from around 80 in July 2014 to 102.6 now so quite an effect will be taking place.

If we look abroad for an impact then the obvious place to look is Tokyo as the Bank of Japan gets what it wants with a plummeting Yen but also faces rising bond yields. It seems set to plough ahead regardless which poses worrying questions for Japanese workers and consumers as rising inflation seems set to impact on real wages.

Meanwhile out song for the day has to be this from Aloe Blacc.

I need a dollar dollar, a dollar is what I need
hey hey
Well I need a dollar dollar, a dollar is what I need
hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me




14 thoughts on “The economic impact of a higher dollar and interest-rate rises

  1. On the subject of interest rates, there was quite an absorbing early radio programme this morning, where the analyst was pointing out that, in highly indebted countries, it is almost impossible for the central banks to maintain “normal” interest rates. He claimed that Japan had twice raised interest rates in the past decade and had to reverse the decision and predicted that the same would be true in Europe and possibly the USA.
    I don’t know whether his facts are right, but his thesis would seem to box in the banks ever more into low interest rates (and therefore, probably, QE).

    • That dilema won’t stop inflation getting out of hand. unnaturally low base rates can lead to currency collapse and economic disaster. Argentina and Venezuala come to mind.

    • The argument is that slightly higher rates hurt highly indebted individuals,companies and Governments leading to a collapse in demand and subsequent economic collapse as more spare cash is consumed by a burgeoning interest payment..

      The reality is that individuals are hurt, companies can hedge loans in foreign currencies (carry trade) which of course carries it’s own risk and Governments can do the same besides QE.

      I believe rates can be increased but very very slowly over a number of years with occasional backtracks as the economic cycle turns if underpinned by a rigorous credit score system before further credit is extended to individuals and companies enforced by law.

      So, as that’s never gonna happen the guy is probably right and Expat is right too. Happy with my answer? Tough!

      • What isn’t said is that Govt and BoE is complicit in this interest rates trap by setting zirp to save the banks.
        More proof that the establishment is at war with the people,

    • This is why I really don’t understand the post Trump rally in US equities. Yes, in a conventional world you would expect money to rotate out of bonds and into stocks, but we’ve had years of unconventional policy, where pretty much everything has been going up owing to QE and ZIRP. This has lead to some pretty daft behaviour. We know, for example, that corporates have been borrowing money at rock bottom rates and buying their own shares with it to push the price up — talk about short termism!

      If the ten year t-bill really does make it to 3% and the dollar keeps on rising, US fiscal policy is going to have to do an awful lot of heavy lifting to offset those currency and interest rate headwinds. I can see the fed having to pause for breath next year. Certainly Carney will be hoping they do, or he may find himself in a difficult spot.

  2. Hi Shaun
    So Carney opines on climate change just as Trump is about to sack half of the EPA and DOE. He sure knows to pick a ‘winner’!
    Of course it is possible the bond market is also under the influence of Putin and its all ‘fake news’.
    Back to what passes for the real world, the BoE will be doing somersaults in 2017.

    • I should add that bond prices are reacting to inflationary forces being way ahead of CB actions, plus at least two large buyers of US Treasuries, China and Japan are throttling back purchases.
      As usual the inflationary effects will hit the UK harder than the US and the BoE will be even further behind the curve. Effect on the UK economy: not good.

      • Hi JW

        It has turned into an intriguing day with all the main currencies hard pressed by the US Dollar. The only relief came when it was reported that Dennis Gartman had opined that parity was on its way between the Euro and the Dollar! Obviously his recent performance as a reverse indicator turned things around a bit. I wonder if he can beat Thomas Stolper?

        As to the UK Gilt market Mark Carney is left rather exposed as most of the £60 billion of QE has now been used as only £13 billion or so is left. Yet tonight the 10 year Gilt yield closed at 1.49% or higher than when it was announced. Whilst the overall portfolio has gains the “Sledgehammer” is offside and the early purchases very much so.

        Moving onto climate change we might well as you say see yet another example of the Forward Guidance of Mark Carney being wrong.

        • The FBI doesn’t believe the CIA’s warmongering on Russian interference in US election, with good reason.
          This is SOOOOOOOOOOOO like the certainty of WMD in Iraq.

  3. Everything is awesome in the US ,a man the main stream media and both political parties told us would be a disaster is President elect.
    Yet US markets are on rocket fuel,interest rates are rising,the dollar is rising the systemic problems including the almost $20T are being ignored,the computer algorithms are buying like there is no tomorrow.Never mind the fundamentals ….Janet has spoken.
    How long can interest rates in UK and EU lag behind the US?
    What happens to all the countries with their debts denominated in US dollars?
    The US is an economic basket case it just attracts more confidence than the other western economic basket cases,the system is dying it may take years but it will die.
    National debt is doubling every 8-9 years on average over the last 4 decades that cannot go on much longer.

    • Hi Private Fraser

      This question of yours will be echoing in more than a few places.

      “What happens to all the countries with their debts denominated in US dollars?”

      Ukraine, Russia, more than a few bits of Africa and so on…Indeed you have reminded me of a paper from the BIS a year ago.

      “Dollar credit to non-banks outside the United States reached $9.8 trillion at end-Q2 2015. Borrowers resident in EMEs accounted for $3.3 trillion of this amount, or over a third. EME nationals resident outside their home countries (for instance, financing subsidiaries incorporated in offshore centres) owed a further $558 billion.” ( EME means emerging market economies)

  4. Hi Shaun, told you they’d raise this year! It could be the wrong move though, have you seen US narrow money since Autumn?

    Unless there’s a surge in narrow money early next year the US will probably be hit by a slowing mid summer 2017 despite Trumponomic fiscal policy and the Fed may be left with egg on it’s face (the first time in a long time in my book) and having to backtrack with cuts. I would have waited till Spring and ignored the critics.

    • Hi Noo2

      They should have done it much sooner then they could have taken a break now in response to the money supply. Meanwhile I expected to hear from you about the ECB as I though we both ended up being right there. I got an extension and the impression it would go on and on and on. But in spite of the denials all over the media both social and ordinary, it was a reduction and thus could be part of a taper. Also there was an official denial from Mario Draghi and we know what they mean!

  5. I saw a post entitled, can the world survive a strong dollar? It can but it would seem with reduced growth. If oil stays the same there must be domestic currency inflation which feeds through oil products. Can increased exports net off the loss in growth by inflation. Power houses like Germany, sure, but not for most. Interest payments on dollar borrowings just make it worse. But Trump.

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